For Metrofinanciera, it's an Uphill Battle to Win Back Trust

It's going to take some effort for Mexican nonbank company Metrofinanciera to win back the confidence of the market.

Shoddy servicing and poor controls on ABS played a part in steep downgrades from Moody's Investors Service two weeks ago, while deteriorating collateral prompted Fitch Ratings and Standard & Poor's to cut the company's deals ratings in late July and August, respectively.

Metrofinanciera replaced its CEO, and indicated that it was correcting its corporate governance, but the damage done to its reputation can't be repaired overnight.

The company managed to pursue questionable practices for years, while simultaneously building business relationships with a number of players in the market. These included the arrangers of its construction loan and mortgage deals: IXE, Deutsche Bank and Credit Suisse; mortgage insurers like Genworth; funders such as government agency Sociedad Hipotecaria Federal (SHF); and the three rating agencies.

In late September, Metro announced that it was replacing CEO Armando Guzman with Jose Landa, who had been heading up GMAC Hipoteciara and GMAC Financiera, and has worked in Mexico's financial sector for about 30 years. In addition, the company said three independent members were appointed to the board and that current shareholders agreed to inject Ps1.3 billion ($95 million) into the company.

The moves were designed in part to "improve corporate governance."

Guzman has stayed on as general director of METROFI, which controls Metrofinanciera, as well as other companies in specialized finance such as Financiera Mexico Multiple, Fondo Inmobiliario Banco de Tierras, and Urbanistika.

Metrofinanciera didn't return calls for comment on this article.

Fitch shed light on just how seriously Metrofinanciera's transaction governance was begging for improvement in the first week of October, when it wrote about inconsistencies in reporting on deals backed by the company's mortgages and construction loan deals. In the case of the latter, there were repeated incidents of trusts reporting zero for the line-item 'interest income and commissions.' But the originator, as servicer, as well as the trustee, confirmed on two occasions within a month that the transfer of interest and commissions had been executed. Fitch had already downgraded these transactions on July 29, citing deterioration in the underlying collateral.

The bigger proverbial bomb came two weeks later. In a report downgrading nine of Metrofinanciera's construction loan deals to a local currency 'Caa1,' Moody's detailed questions of governance in the company's construction loan transactions. The agency was concerned with the "oversight of developers, reporting, collections, remittances, disbursements, approval of extensions to a construction loan's original maturity" and other issues.

One particularly egregious example of poor management was the fact that not a single developer that had taken out the construction loans in Metrofinanciera's securitized deals was depositing the money with the ABS trusts.

"This goes against the transaction documents," said Karen Ramallo, an analyst at Moody's. The agency reported that the company said it has attempted to instruct developers to remit payments directly into the trust accounts, but to no avail. Additionally, Metrofinanciera did not apparently explain why developers in its transactions would be so reticent to follow the trust documents, when developers in other transactions don't appear to have the same depositing issues.

Metrofinanciera also repurchased and replaced presumably problematic loans in current ABS. "We did detect some lumpy principal payments," Ramallo said. While this can tamp down delinquency numbers, under the terms of the transactions, the company has no obligation to continue intervening in this fashion.

Moody's downgrade came a few months after it placed an initial clutch of transactions on review for possible downgrade. In April, Metro's six construction-loan ABS issued before 2007 were placed on review, and in July the remaining three transactions were put on review as well. "We generally attempt to resolve this in three months, but [in this case] we didn't have the information to resolve the issue," said Maria Muller, senior vice president at Moody's.

While also expressing concern about the corporate governance issue, Fitch and S&P downgraded the transactions based primarily on their deteriorating performance. Fitch downgraded four deals it rates on July 29, and kept them on Rating Watch Negative. The senior tranches of the transactions are now at 'A(mex)' or, in the case of a cross-border deal, 'BB.' Meanwhile, S&P downgraded some deals on Aug.1, and also left them on Watch Negative. In neither case were deals dunked anywhere close to where the Moody's rating would end up, at 'Caa1.'

All agencies agree that the delinquencies in the construction loan portfolios were troubling. For one series of construction loan ABS, S&P pointed out that delinquencies had reached 35.64% in total and 1.92% over 90 days. For the nine deals it rates, Moody's reported serious delinquencies-loans that are delinquent 30 days or more with respect to principal payments, or 90 days or more regarding interest payments-at between 15% and 80% of the total loan pool balance. The more seasoned transactions are close to the 60% to 80% range, while the younger ones have lower delinquencies.

Apart from its particular issues, the company is suffering from the same problems afflicting its peers, albeit in magnified form. "The home sales cycles have lengthened. Everyone's having that problem," said Greg Kabance, director of Latin American structured ratings at Fitch. "It's also related to mortgage market financing, as overall mortgage origination has not reached expected levels during 2008."

In construction loan transactions, developers make payments of interest and principal into the issuing trust. These credits are typically taken out by mortgage financing before the loan matures, with the originator using those proceeds to take out more construction loans.

Metrofinanciera's new administration is now under heightened scrutiny. "We're looking closely at the new management team," said Juan Pablo de Mollein, managing director at S&P.

He added that the changes proposed to servicing practices will be key to improving the transaction ratings. "In revolving assets securitizations, the servicer role is key. We are currently reviewing their servicer operation and some changes that they are proposing to introduce, and we will evaluate [the] results in the next few weeks."

S&P lowered its servicer ranking for Metrofinanciera as a construction loan servicer on Aug. 8 to Average with a stable outlook from Above Average. No changes have been made since then.

While all observers welcome the management changes, not everyone seems to think they go far enough. In a report on the company's corporate governance, Moody's noted that while Metro's taking on a new CEO and two independent board members is a positive step, "the firm's previous CEO still remains part of the corporate holding company."

Moody's analysts declined to elaborate on the agency's view on Metro retaining Guzman.

One of the reasons Fitch hasn't dunked ratings further is perceived support from government agency SHF.

"Fitch considers that the propensity of external support by SHF for systematically-important mortgage companies is increasingly an important rating consideration and it effectively sets a rating floor for these companies," the agency said in a report released last week. It went on to add that the Metrofinanciera downgrades of mid-August "considered that such action by SHF was likely if it became necessary to act explicitly to assure the continued smooth functioning of local capital markets."

As a government entity, the SHF's creditworthiness is generally considered on par with that of the Mexican government, which is investment grade on the global scales of all three rating agencies.

Fitch said the issuer default rating of "systemically-important" intermediaries, where significant SHF support is evident, is unlikely to be downgraded beyond 'B+.' As the bridge loan deals are revolvers, they are strongly linked to originator. "When we downgraded the Metrofinanciera transactions, we weren't downgrading them much more than that because of their link to the corporate and the implicit and explicit support offered by SHF," Kabance said.

Fitch affirmed the corporate's long-term issuer default of 'B+' in August. S&P has had the corporate on long-term 'B' with a negative outlook since the same month. In mid October, Moody's downgraded the global scale local currency issuer to 'B3.'

In its report, Fitch said that the SHF had approved a $200 million credit line to Metrofinanciera under a recent program designed to alleviate liquidity problems in the housing finance sector.

However, an official with the SHF said that the agency hadn't earmarked anything yet for particular companies as part of a Ps40 billion support package for housing sector finance companies that was announced in mid October.

As for Metrofinanciera's corporate governance, the official said that the agency was anticipating that the originator would institute changes under new management. He declined to comment on speculation that the SHF played an active role in personnel moves at Metrofinanciera.

The SHF's liquidity support, which is financed in part by loans from the InterAmerican Development Bank and World Bank, can take various forms, including credit lines for construction loans, guarantees on construction loans and on ABS, credit lines for home purchases, and other tools of support.

The corporate faces steep short-term maturities with more than Ps450 million in commercial paper due in what remains of this year, and Ps1.7 billion maturing in 2009.